chapter 2 · the major differences between current liabilities and long-term liabilities are: ......

Full file at https://fratstock.eu

Copyright © 2009 John Wiley & Sons, Inc. Kimmel, Accounting, 3/e, Solutions Manual (For Instructor Use Only) 2-1

CHAPTER 2

A Further Look at Financial Statements

ASSIGNMENT CLASSIFICATION TABLE

Study Objectives

Questions

Brief

Exercises

Do It!

Exercises

A

Problems

B

Problems

1. Identify sections of a

classified balance sheet.

1, 2, 3, 4, 5,

21

1, 2 1, 2 1, 2, 3, 4,

5, 6, 8

1, 2, 3 1, 2, 3

2. Identify and compute

ratios for analyzing a

company’s profitability.

6, 7, 11, 3 7 4, 5, 6, 7 4, 5, 6, 7

3. Explain the relationship

between a retained

earnings statement and a

statement of stockholders’

equity.

4 8 2, 3 2, 3

4. Identify and compute ratios

for analyzing a company’s

liquidity and solvency

using a balance sheet.

6, 7, 8, 9,

10, 11

5, 6 3 8, 9,

10, 11

4, 5, 6, 7 4, 5, 6, 7

5. Use the statement of cash

flows to evaluate

solvency.

6, 7, 9,

10, 11

6 3 11 4, 5, 6, 7 4, 5, 6, 7

6. Explain the meaning of

generally accepted

accounting principles.

12, 13, 17 7 8 8

7. Discuss financial

reporting concepts.

13, 14, 15,

16, 18, 19,

20

8, 9, 10,

11, 12

4 12, 13 8 8


2-2 Copyright © 2009 John Wiley & Sons, Inc. Kimmel, Accounting, 3/e, Solutions Manual (For Instructor Use Only)

ASSIGNMENT CHARACTERISTICS TABLE

Problem

Number

Description

Difficulty

Level

Time

Allotted (min.)

1A Prepare a classified balance sheet. Simple 10–20

2A Prepare financial statements. Moderate 20–30

3A Prepare financial statements. Moderate 20–30

4A Compute ratios; comment on relative profitability,

liquidity, and solvency.

Moderate 20–30

5A Compute and interpret liquidity, solvency, and profitability

ratios.

Simple 10–20

6A Compute and interpret liquidity, solvency, and profit-

ability ratios.

Moderate 15–25

7A Compute ratios and compare liquidity, solvency, and

profitability for two companies.

Moderate 15–25

8A Comment on the objectives and qualitative characteristics

of Financial reporting.

Simple 10–20

1B Prepare a classified balance sheet. Simple 10–20

2B Prepare financial statements. Moderate 20–30

3B Prepare financial statements. Moderate 20–30

4B Compute ratios; comment on relative profitability,

liquidity, and solvency.

Moderate 20–30

5B Compute and interpret liquidity, solvency, and profitability

ratios.

Simple 10–20

6B Compute and interpret liquidity, solvency, and profit-

ability ratios.

Moderate 15–25

7B Compute ratios and compare liquidity, solvency, and

profitability for two companies.

Moderate 15–25

8B Comment on the objectives and qualitative characteristics

of accounting information.

Simple 10–20



ANSWERS TO QUESTIONS

1. A company’s operating cycle is the average time that is required to go from cash to cash in prod-

ucing revenues.

2. Current assets are cash and other resources that are reasonably expected to be realized in cash or

sold or consumed in the business within one year of the balance sheet date or the company’s

operating cycle, whichever is longer. Current assets are listed in the order in which they are exp-

ected to be converted into cash.

3. Long-term investments are investments in stocks and bonds of other companies where the

conversion into cash is not expected within one year or the operating cycle, whichever is longer.

Property, plant, and equipment are tangible resources of a relatively permanent nature that are being

used in the business and not intended for sale.

4. The major differences between current liabilities and long-term liabilities are:

Difference Current Liabilities Long-term Liabilities

Source of payment. Existing current assets or other current liabilities.

Other than existing current assets or creating current liabilities.

Time of expected payment.

Within one year or the operating cycle, whichever is longer.

Beyond one year or the operating cycle.

Nature of items. Debts pertaining to the operating

cycle and other short-term debts.

Mortgages, bonds, and other long-term liabilities.

5. The two parts of stockholders’ equity and the purpose of each are: (1) Common stock is used to

record investments of assets in the business by the owners (stockholders). (2) Retained earnings is

used to record net income retained in the business.

6. (a) Glenda is not correct. There are three characteristics: liquidity, profitability, and solvency.

(b) The three parties are not primarily interested in the same characteristics of a company.

Short-term creditors are primarily interested in the liquidity of the enterprise. In contrast,

long-term creditors and stockholders are primarily interested in the profitability and solvency

of the company.

7. (a) Liquidity ratios: Working capital and current ratio.

(b) Solvency ratios: Debt to total assets and free cash flow.

(c) Profitability ratio: Earnings per share.

8. Debt financing is riskier than equity financing because debt must be repaid at specific points in time,

whether the company is performing well or not. Thus, the higher the percentage of assets financed

by debt, the riskier the company.



Questions Chapter 2 (Continued)

9. (a) Liquidity ratios measure the short-term ability of the company to pay its maturing obligations and

to meet unexpected needs for cash.

(b) Profitability ratios measure the income or operating success of a company for a given period of

time.

(c) Solvency ratios measure the company’s ability to survive over a long period of time.

10. (a) The increase in earnings per share is good news because it means that profitability has improved.

(b) An increase in the current ratio signals good news because the company improved its ability to

meet maturing short-term obligations.

(c) The increase in the debt to total assets ratio is bad news because it means that the company

has increased its obligations to creditors and has lowered its equity “buffer.”

(d) A decrease in free cash flow is bad news because it means that the company has become less

solvent. The higher the free cash flow, the more solvent the company.

11. (a) The debt to total assets ratio and free cash flow which indicate the company’s ability to repay

the face value of the debt at maturity and make periodic interest payments.

(b) The current ratio and working capital, which indicate a company’s liquidity and short-term debt-

paying ability.

(c) Earnings per share indicates the earning power (profitability) of an investment.

12. (a) Generally accepted accounting principles (GAAP) are a set of rules and practices, having

substantial support, that are recognized as a general guide for financial reporting purposes.

(b) The body that provides authoritative support for GAAP is the Financial Accounting Standards

Board (FASB).

13. (a) The basic objective of financial reporting is to provide information useful for decision making.

(b) The qualitative characteristics are (1) relevance, (2) reliability, (3) comparability, and

(4) consistency.

14. Morton is correct. Consistency means using the same accounting principles and accounting methods

from period to period within a company. Without consistency in the application of accounting

principles, it is difficult to determine whether a company is better off, worse off, or the same from

period to period.

15. Comparability results when different companies use the same accounting principles. Consistency

means using the same accounting principles and methods from year to year within the same

company.



Questions Chapter 2 (Continued)

16. The two constraints are materiality and conservatism. The materiality constraint means that an item

may be so small that failure to follow generally accepted accounting principles will not influence the

decision of a reasonably prudent investor or creditor. The conservatism constraint means that when

in doubt, the accountant chooses the accounting method that is least likely to overstate assets and

net income.

17. There is little uniformity in accounting standards from country to country, although some efforts have

been made in this area by the International Accounting Standards Board.

18. The going concern assumption lends credibility to the cost principle because it is assumed that the

assets will be used in the business and what you gave up to acquire these assets is more relevant

than what the assets could be sold for. If the company was not a going concern, items would be

reported at liquidation value.

19. Cost is used as a basis for accounting treatment and reporting because it is both relevant and

reliable. Cost is relevant because it represents the price paid, the assets sacrificed, or the com-

mitment made at the date of acquisition. It is the amount for which someone or some entity should be

accountable. Cost is reliable because it is objectively measurable, factual, and verifiable. It is the

result of an arm’s-length exchange transaction. As a result, cost is the basis used in preparing

financial statements.

20. The economic entity assumption states that every economic entity can be separately identified and

accounted for. This assumption requires that the activities of the entity be kept separate and distinct

from (1) the activities of its owners (the shareholders) and (2) all other economic entities. A shareholder

of a company charging personal living costs as expenses of the company is an example of a violation

of the economic entity assumption.

21. At December 31, 2007 Tootsie Roll’s largest current asset was Cash and Cash Equivalents of

$57,606,000, its largest current liability is accrued liabilities of $42,056,000 and its largest item under

other assets was trademarks of $189,024,000.



SOLUTIONS TO BRIEF EXERCISES

BRIEF EXERCISE 2-1 CL Accounts payable CL Income tax payable CA Accounts receivable LTI Investment in long-term bonds PPE Accumulated depreciation PPE Land PPE Building CA Merchandise inventory CA Cash IA Patent IA Goodwill CA Supplies BRIEF EXERCISE 2-2

RONDELLI COMPANY Partial Balance Sheet

Current assets Cash ......................................................................................... $10,400 Short-term investments .......................................................... 8,200 Accounts receivable ............................................................... 14,000 Supplies ................................................................................... 3,800 Prepaid insurance ................................................................... 3,300 Total current assets ........................................................ $39,700

BRIEF EXERCISE 2-3

Earnings per share = Net income-Preferred stock dividends

Average common shares outstanding

= $676 million

402 million shares = $1.68 per share

BRIEF EXERCISE 2-4

ICS Issued new shares of common stock DRE Paid a cash dividend IRE Reported net income of $75,000 DRE Reported net loss of $20,000



BRIEF EXERCISE 2-5

Working capital = Current assets – Current liabilities

Current assets ($102,500,000 Current liabilities 201,200,000 Working capital ($ 98,700,000) Current ratio:

Current assets

Current liabilities =

$102,500,000

$201,200,000

= .51:1 BRIEF EXERCISE 2-6

(a) Current ratio $262,787

$293,625 = 0.89:1

(b) Debt to total assets $376,002

$439,832 = 85.5%

(c) Free cash flow $55,472 – $24,787 – $15,000 = $15,685

BRIEF EXERCISE 2-7 (a) True. (b) False. BRIEF EXERCISE 2-8 (a) Forecasts/predicts. (b) Confirms or corrects/provides feedback. (c) Verifiable. (d) Faithful representation. (e) Comparability.



BRIEF EXERCISE 2-9 (a) Relevant. (b) Reliability. (c) Consistency. BRIEF EXERCISE 2-10 (a) 1. Predictive value. (b) 2. Neutral. (c) 3. Verifiable. (d) 4. Timely. BRIEF EXERCISE 2-11 (c) BRIEF EXERCISE 2-12 (a) Conservatism. (b) Materiality. (c) Materiality.

SOLUTIONS TO DO IT! REVIEW EXERCISES

DO IT! 2-1

THEREMIN CORPORATION Balance Sheet (partial)

December 31, 2010

Assets Current assets Cash ................................................................. $ 13,000 Accounts receivable ......................................... 22,000 Inventory ........................................................... 58,000 Supplies ............................................................ 9,000 Total current assets ............................... $102,000 Property, plant, and equipment Equipment ......................................................... $180,000 Less: Accumulated depreciation .................... 45,000 135,000 Total assets ............................................................... $237,000



DO IT! 2-2 IA Trademarks CA Inventories

CL Current maturities of long-term debt PPE Accumulated depreciation

NA Interest revenue PPE Land improvements

CL Taxes payable SE Common stock

LTI Long-term marketable debt securities NA Advertising expense

CL Unearned consulting fees LTL Mortgage note payable due in

3 years

DO IT! 2-3 (a) 2010 2009 ($80,000 – $6,000)

= $1.29 ($40,000 – $6,000)

= $0.97 (40,000 + 75,000)/2 (30,000 + 40,000)/2

Allotrope’s profitability, as measured by the amount of income available for each share of common stock, increased by 33 percent (($1.29 – $0.97)/$0.97) during 2010. Earnings per share should not be compared across companies because the number of shares issued by companies varies widely. Thus, we cannot conclude that Allotrope Corporation is more profitable based on its higher EPS in 2010.

(b) 2010 2009

Current ratio $54,000

= 2.25:1 $36,000

= 1.09:1 $24,000 $33,000

Debt to total assets ratio

$72,000 = 30%

$100,000 = 49%

$240,000 $205,000

The company’s liquidity, as measured by the current ratio improved from 1.09:1 to 2.25:1. Its solvency also improved, because the debt to total assets ratio declined from 49% to 30%.

(c)

Free cash flow 2010: $90,000 – $6,000 – $3,000 – $27,000 = $54,000 2009: $56,000 – $6,000 – $1,500 – $12,000 = $36,500

The amount of cash generated by the company above its needs for dividends and capital expenditures increased from $36,500 to $54,000.



DO IT! 2-4 1. Monetary unit assumption 2. Reliability 3. Economic entity assumption 4. Conservatism 5. Consistency 6. Cost principle 7. Relevance 8. Time period assumption 9. Full disclosure principle 10. Materiality 11. Going concern assumption 12. Comparability



SOLUTIONS TO EXERCISES EXERCISE 2-1 CL Accounts payable and CL Income taxes payable accrued liabilities CA Inventories CA Accounts receivable LTI Investments PPE Accumulated depreciation PPE Land PPE Buildings LTL Long-term debt CA Cash and short-term

investments Dividends payable Goodwill

CA Materials and supplies CL IA

PPE Office equipment and furniture

CA Prepaid expenses EXERCISE 2-2 CA Prepaid expenses LTI Land held for future use PPE Machinery and equipment IA Patents IA Trademarks LTL Bonds payable CL Dividends payable SE Common stock CL Taxes payable PPE Accumulated depreciation SE Retained earnings CL Unearned revenue CA Accounts receivable CA Inventory



EXERCISE 2-3

BOEING COMPANY Partial Balance Sheet

December 31, 2006 (in millions)

Assets Current assets Cash and cash equivalents .................................. $ 6,118 Short-term investments ........................................ 268 Accounts receivable ............................................. 5,285 Notes receivable—due before December 31, 2007 ............................................ 370 Inventories ............................................................. 8,105 Other current assets ............................................. 2,837 Total current assets ...................................... $22,983 Notes receivable—due after December 31, 2007 ........ 12,605 Property, plant, and equipment ................................... 19,310 Less: Accumulated depreciation ................................ 11,635 7,675 Intangible assets .......................................................... 4,745 Other noncurrent assets .............................................. 3,786 Total assets ................................................................... $51,794



EXERCISE 2-4

H. J. HEINZ COMPANY Partial Balance Sheet

May 2, 2007 (in thousands)

Assets Current assets Cash and cash equivalents .............. $ 652,896 Accounts receivable ......................... 996,852 Inventories ........................................ 1,197,957 Prepaid expenses ............................. 132,561 Other current assets ........................ 38,736 Total current assets .................. $ 3,019,002 Property, plant, and equipment Land................................................... 51,950 Buildings and equipment ................. $4,002,913 Less: Accumulated depreciation ..... 2,056,710 1,946,203 1,998,153 Intangible assets ..................................... 4,139,872 Other noncurrent assets ........................ 875,999 Total assets ............................................. $10,033,026



EXERCISE 2-5

CLELAND COMPANY Balance Sheet

December 31, 2010

Assets Current assets Cash ..................................................... $11,840 Accounts receivable ........................... 12,600 Prepaid insurance ............................... 4,680 Total current assets .................... $ 29,120 Property, plant, and equipment Land ..................................................... 61,200 Building ............................................... $105,800 Less: Accumulated depreciation— building .................................... 45,600 60,200 Equipment ........................................... 82,400 Less: Accumulated depreciation— equipment ................................ 18,720 63,680 185,080 Total assets ................................. $214,200

Liabilities and Stockholders’ Equity Current liabilities Accounts payable ............................... $ 9,500 Current portion of note payable .......... 13,600 Interest payable .................................. 3,600 Total current liabilities ................ $ 26,700 Long-term liabilities Note payable ($93,600 – $13,600) ....... 80,000 Total liabilities ............................. 106,700 Stockholders’ equity Common stock .................................... 62,000 Retained earnings ($40,000 + $5,500*) ............................ 45,500 Total stockholders’ equity .......... 107,500 Total liabilities and stockholders’ equity ................ $214,200 *Net income = $14,180 – $780 – $5,300 – $2,600 = $5,500



EXERCISE 2-6

TEXAS INSTRUMENTS, INC. Balance Sheet


Assets Current assets Cash and cash equivalents ..................................... $ 1,183 Short-term investments ........................................... 2,534 Accounts receivable ................................................ 1,774 Inventories ................................................................ 1,437 Prepaid expenses ..................................................... 181 Other current assets ................................................ 745 Total current assets .......................................... $ 7,854 Long-term investments ................................................... 287 Property, plant, and equipment Property, plant, and equipment ............................... 7,751 Less: Accumulated depreciation ........................... (3,801) 3,950 Other noncurrent assets ................................................. 1,839 Total assets ...................................................................... $13,930

Liabilities and Stockholders’ Equity Current liabilities Accounts payable .................................................... $ 560 Note payable in 2007 ................................................ 43 Other current liabilities ............................................ 1,475 Total current liabilities ..................................... $ 2,078 Noncurrent liabilities Noncurrent liabilities ................................................ 492 Total liabilities .................................................................. 2,570 Stockholders’ equity Common stock ......................................................... 2,624 Retained earnings .................................................... 8,736 Total stockholders’ equity ............................... 11,360 Total liabilities and stockholders’ equity ....................... $13,930



EXERCISE 2-7

(a) Earnings per share = Net income–Preferred stock dividends


2006 : $23, 290,000 – 0

(67,954, 213 + 70,495,136) / 2 = $ .34

2005 : $13,284,000 – 0

(70,495,136+ 69,111,349) / 2 = $ .19

(b) Using net income (loss) as a basis to evaluate profitability, Callaway

Golf’s income improved by 75% between 2005 and 2006. Its earnings per share increased by 79%.

(c) To determine earnings per share, dividends on preferred stock are

subtracted from net income, but dividends on common stock are not subtracted.



EXERCISE 2-8 (a) BARONE CORPORATION Income Statement For the Year Ended July 31, 2010

Revenues Commission revenue .................................... $66,100) Rent revenue .................................................. 8,500) Total revenues ........................................ $74,600) Expenses Salaries expense ........................................... 51,700 Utilities expense ............................................ 22,600 Depreciation expense .................................... 4,000 Total expenses ....................................... 78,300) Net loss .................................................................. $( 3,700) BARONE CORPORATION Retained Earnings Statement For the Year Ended July 31, 2010

Retained earnings, August 1, 2009 ...................... $35,200) Less: Net loss ...................................................... $3,700 Dividends ................................................... 4,000 7,700) Retained earnings, July 31, 2010 ......................... $27,500)

(b) BARONE CORPORATION Balance Sheet July 31, 2010

Assets Current assets Cash ................................................................ $29,200) Accounts receivable ...................................... 9,780) Total current assets ............................... $38,980) Property, plant, and equipment Equipment ...................................................... $18,500 Less: Accumulated depreciation ................ 6,000 12,500) Total assets ............................................ $51,480)



EXERCISE 2-8 (Continued) (b) BARONE CORPORATION Balance Sheet (Continued) July 31, 2010

Liabilities and Stockholders’ Equity Current liabilities Accounts payable ............................................. $ 4,100 Salaries payable ................................................ 2,080 Total current liabilities ................................. $ 6,180 Long-term note payable .......................................... 1,800 Total liabilities .............................................. 7,980 Stockholders’ equity Common stock .................................................. 16,000 Retained earnings ............................................. 27,500 Total stockholders’ equity ........................... 43,500 Total liabilities and stockholders’ equity ... $51,480

(c) Current ratio =$38,980

$6,180= 6.3 :1

Debt to total assets ratio =$7,980

$51,480= 15.5%

(d) The current ratio would not change because equipment is not a current

asset and a 5-year note payable is a long-term liability rather than a current liability.

The debt to total assets ratio would increase from 15.5% to 39.1%*.

Looking solely at the debt to total assets ratio, I would favor making the sale because Barone’s debt to total assets ratio of 15.5% is very low. Looking at additional financial data, I would note that Barone reported a significant loss for the current year which would lead me to question its ability to make interest and loan payments (and even remain in business) in the future. I would not make the proposed sale unless Barone convinced me that it would be capable of earnings in the future rather than losses.

I would also consider making the sale but requiring a substantial down- payment and smaller note.

*($7,980 + $20,000) ÷ ($51,480 + $20,000)



EXERCISE 2-9 (a) Beginning of Year End of Year Working capital $2,874 – $1,623 = $1,251 $2,742 – $1,433 = $1,309

Current ratio $2,874

$1,623 = 1.77:1

$2,742

$1,433 = 1.91:1

(b) Nordstrom’s liquidity increased during the year. Its current ratio

increased from 1.77:1 to 1.91:1. Also, Nordstrom’s working capital increased by $58 million.

(c) Nordstrom’s current ratio at both the beginning and the end of the recent year exceeds Best Buy’s current ratio for 2007 (and 2006). Nordstrom’s end-of-year current ratio (1.91) exceeds Best Buy’s 2007 current ratio (1.44). Nordstrom would be considered more liquid than Best Buy for the recent year.

EXERCISE 2-10

(a) Current ratio =$70,000

$40,000= 1.8 : 1

Working capital = $70,000 – $40,000 = $30,000

(b) Current ratio =$45,000*

$15,000**= 3.0 : 1

Working capital = $45,000 – $15,000 = $30,000

*$70,000 – $25,000 **$40,000 – $25,000 (c) Liquidity measures indicate a company’s ability to pay current obligations

as they become due. Satisfaction of current obligations usually requires the use of current assets.

If a company has more current assets than current liabilities it is more

likely that it will meet obligations as they become due. Since working capital and the current ratio compare current assets to current liabilities, both are measures of liquidity.



EXERCISE 2-10 (Continued) Payment of current obligations frequently requires cash. Neither work-ing

capital nor the current ratio indicate the composition of current assets. If a company’s current assets are largely comprised of items such as inventory and prepaid expenses it may have difficulty paying current obligations even though its working capital and current ratio are large enough to indicate favorable liquidity. In Greenstem’s case, payment of $25,000 of accounts payable will leave only $5,000 cash. Since salaries payable will require $15,000, the company may need to borrow in order to make the required payment for salaries.

(d) The CFO’s decision to use $25,000 of cash to pay off accounts payable is

not in itself unethical. However doing so just to improve the year-end current ratio could be considered unethical if this action misled creditors. Since the CFO requested preparation of a “preliminary” balance sheet before deciding to pay off the liabilities he seems to be “managing” the company’s financial position which is usually considered unethical.

EXERCISE 2-11 2007 2006

(a) Debt to total assets ratio

$570,172

$1, 987, 484 = 28.7%

$450, 097

$1, 605, 649 = 28.0%

(b)

Free cash flow $749,268 – $225,939 – $61,521 = $461,808

$480,419 – $81,545 – $42,058 = $356,816

(c) Using the debt to total assets ratio and free cash flow as measures of

solvency produces mixed results for American Eagle Outfitters. Its debt to total assets ratio increased slightly from 28.0% for 2006 to 28.7% for 2007 indicating a decline in solvency for 2007. In contrast, its free cash flow increased by 29% indicating a good improvement in solvency.

(d) In both 2007 and 2006 American Eagle Outfitters’s cash provided by

operating activities was greater than the cash used for capital expenditures. It is generating plenty of cash from operations to cover its investing needs. This is not unusual for a company that has been operating successfully for more than ten years, as has been the case with American Eagle Outfitters. If it faced a deficiency, it could meet it by issuing stock or debt.



EXERCISE 2-12 (a) 2 Going concern assumption (b) 6 Economic entity assumption (c) 3 Monetary unit assumption (d) 4 Time period assumption (e) 5 Cost principle (f) 1 Full disclosure principle EXERCISE 2-13 (a) This is a violation of the cost principle. The inventory was written up to its

market value when it should have remained at cost. (b) This is a violation of the economic entity assumption. The treatment of the

transaction treats Dipak Ghosh and Ghosh Co. as one entity when they are two separate entities. The cash used to purchase the truck should have been treated as part of salaries expense.

(c) This is a violation of the time period assumption. This assumption states

that the economic life of a business can be divided into artificial time periods (months, quarters, or a year). By adding two more weeks to the year, Ghosh Co. would be misleading financial statement readers. In addition, 2010 results would not be comparable to previous years’ results. The company should use a 52 week year.



SOLUTIONS TO PROBLEMS

PROBLEM 2-1A

YAHOO! INC. Balance Sheet

December 31, 2006

Assets Current assets Cash and cash equivalents ................ $ 1,569,871 Short-term investments ...................... 1,031,528 Accounts receivable ........................... 930,964 Prepaid expenses and other current assets .................................. 217,779 Total current assets .................... $ 3,750,142 Long-term investments .............................. 2,827,720 Property and equipment, net ..................... 1,101,379 Intangible assets ........................................ 3,374,379 Other assets ................................................ 459,988 Total assets ......................................... $11,513,608

Liabilities and Stockholders’ Equity Current liabilities Accounts payable ............................... $ 109,130 Accrued expenses and other current liabilities .............................. 1,046,882 Unearned revenue-current ................. 317,982 Total current liabilities ................ $ 1,473,994 Long-term liabilities Long-term debt ................................... 749,915 Other long-term liabilities ................... 129,089 Total long-term liabilities ............ 879,004 Total liabilities .......................... 2,352,998 Stockholders’ equity Common stock .................................... 5,292,545 Retained earnings ............................... 3,868,065 Total stockholders’ equity .................. 9,160,610 Total liabilities and stockholders’ equity ................................................ $11,513,608



PROBLEM 2-2A

FINN CORPORATION Income Statement

For the Year Ended December 31, 2010

Revenues Service revenue ..................................................... $72,000 Expenses Salaries expense ................................................... $37,000 Depreciation expense ........................................... 3,300 Insurance expense ................................................ 2,200 Utilities expense .................................................... 2,000 Repair expense ...................................................... 1,800 Total expenses ............................................... 46,300 Net income .................................................................... $25,700

FINN CORPORATION Retained Earnings Statement


Retained earnings, January 1, 2010 .............................................. $31,000 Add: Net income ........................................................................... 25,700 56,700 Less: Dividends ............................................................................. 12,000 Retained earnings, December 31, 2010 ......................................... $44,700



PROBLEM 2-2A (Continued)

FINN CORPORATION Balance Sheet

December 31, 2010

Assets Current assets Cash ....................................................................... $12,900 Accounts receivable ............................................. 14,200 Prepaid insurance ................................................. 3,500 Total current assets ...................................... $30,600 Property, plant, and equipment Equipment ............................................................. 66,000 Less: Accumulated depreciation ........................ 17,600 48,400 Total assets ................................................... $79,000

Liabilities and Stockholders’ Equity Current liabilities Accounts payable ................................................. $18,300 Salaries payable .................................................... 3,000 Total current liabilities .................................. $21,300 Stockholders’ equity Common stock ...................................................... 13,000 Retained earnings ................................................. 44,700 Total stockholders’ equity ............................ 57,700 Total liabilities and stockholders’ equity ..... $79,000



PROBLEM 2-3A

(a) KILEY ENTERPRISES

Income Statement For the Year Ended April 30, 2010

Revenues ............................................................... $4,600 Expenses Cost of good sold .......................................... $990 Wages expense ............................................ 700 Interest expense ............................................ 400 Depreciation expense ................................... 335 Selling expenses ........................................... 210 Income tax expense ...................................... 165 Total expenses ....................................... 2,800 Net income ............................................................. $1,800

KILEY ENTERPRISES

Retained Earnings Statement For the Year Ended April 30, 2010

Retained earnings, May 1, 2009 ............................ $1,600 Add: Net income ................................................. 1,800 3,400 Less: Dividends .................................................... 325 Retained earnings, April 30, 2010 ......................... $3,075



PROBLEM 2-3A (Continued) (b) KILEY ENTERPRISES

Balance Sheet April 30, 2010

Assets

Current assets Cash ................................................................... $1,270 Short-term investments .................................... 1,200 Accounts receivable .......................................... 810 Inventories ......................................................... 967 Prepaid expenses .............................................. 12 Total current assets................................... $4,259 Property, plant, and equipment Land. ................................................................... 2,100 Building, net of accumulated depreciation ...... 1,537 Equipment, net of accumulated depreciation .................................................... 1,220 Total property, plant, and equipment ....... $4,857 Total assets ................................................ $9,116

Liabilities and Stockholders’ Equity

Current liabilities Accounts payable ............................................. $ 834 Current portion of long term debt .................... 450 Wages payable .................................................. 222 Income taxes payable ....................................... 135 Total current liabilities .............................. $1,641 Long term debt ......................................................... 3,500 Total liabilities ............................................ 5,141 Stockholders’ equity Common stock .................................................. 900 Retained earnings ............................................. 3,075 Total stockholders’ equity ........................ 3,975 Total liabilities and stockholders’ equity ........ $9,116



PROBLEM 2-4A

(a) Bedene Company appears to be more profitable.

Its net income for 2010 is $328,000 ($1,900,000 – $1,175,000 – $303,000– $9,000 – $85,000). Its earnings per share is $3.28 ($328,000 ÷ 100,000 shares outstanding). Groneman’s net income for 2010 is $142,200 ($620,000 – $340,000 – $98,000 – $3,800 – $36,000). Its earnings per share is $2.84 ($142,200 ÷ 50,000 shares outstanding).

(b) Bedene appears to be more liquid. Bedene’s 2010 working capital of $340,875 ($407,200 – $66,325) is more than twice as high as Groneman’s working capital of $149,988 ($190,336 – $40,348). In addition, Bedene’s 2010 current ratio of 6.1:1 ($407,200 ÷ $66,325) is higher than Groneman’s current ratio of 4.7:1 ($190,336 ÷ $40,348).

(c) Bedene appears to be slightly more solvent. Bedene’s 2010 debt to total assets ratio of 18.6% ($174,825 ÷ $939,200)a is lower than Groneman’s ratio of 21.2% ($69,968 ÷ $330,064)b. The lower the percentage of debt to total assets, the lower the risk that a company may be unable to pay its debts as they come due.

Another measure of solvency, free cash flow, also indicates that Bedene is

more solvent. Bedene had $12,000 ($138,000 – $90,000 – $36,000) of free cash flow while Groneman had only $1,000 ($36,000 – $20,000 – $15,000).

a$174,825 ($66,325 + $108,500) is Bedene’s 2010 total liabilities. $939,200 ($407,200 + $532,000) is Bedene’s 2010 total assets.

b$69,968 ($40,348 + $29,620) is Groneman’s 2010 total liabilities. $330,064 ($190,336 + $139,728) is Groneman’s 2010 total assets.



PROBLEM 2-5A

(a) (i) Working capital = $428,900 – $215,500 = $213,400.

(ii) Current ratio = $428,900

$215,500 = 2.0:1.

(iii) Free cash flow = $190,800 – $92,000 – $31,000 = $67,800

(iv) Debt to total assets ratio = $415,500

$1,054,200 = 39.4%.

(v) Earnings per share = $133,100

50,000 shares = $2.66.

(b) During 2010, the company’s current ratio increased from 1.65:1 to 2.0:1 and its working capital increased from $160,500 to $213,400. Both measures indicate an improvement in liquidity during 2010.

The company’s debt to total assets ratio increased from 31.0% in 2009 to 39.4% in 2010 indicating that the company is less solvent in 2010. Another measure of solvency, free cash flow, increased from $48,700 to $67,800. This suggests an improvement in solvency, thus we have conflicting measures of solvency.

Earnings per share decreased from $3.15 in 2009 to $2.66 in 2010. This indicates a decline in profitability during 2010.



PROBLEM 2-6A

2009 2010

(a) Earnings per share.

$50,000

30,000 shares = $1.67

$70,000

33,000 shares = $2.12

(b)

Working capital.

($20,000 + $62,000 + $73,000) – $70,000 = $85,000

($25,000 + $70,000 + $80,000) – $75,000 = $100,000

(c)

Current ratio.

$155,000

$70,000 = 2.2:1

$175,000

$75,000 = 2.3:1

(d)

Debt to total assets ratio.

$160,000

$685,000 = 23.4%

$155,000

$760,000 = 20.4%

(e) Free cash flow.

$60,000 – $38,000 – $15,000 = $7,000

$87,000 – $45,000 – $20,000 = $22,000

(f) Net income and earnings per share have increased indicating that the underlying profitability of the corporation has improved. The liquidity of the corporation as shown by the working capital and the current ratio has improved slightly. Also, the corporation improved its solvency by improving its debt to total assets ratio as well as free cash flow.



PROBLEM 2-7A

Ratio Target Wal-Mart

(All Dollars Are in Millions)

(a) Working capital $14,706 – $11,117 = $3,589 $46,588 – $51,754 = ($5,166)

(b) Current ratio 1.3:1 ($14,706 ÷ $11,117) .90:1 ($46,588 ÷ $51,754)

(c) Debt to total assets ratio 58.1% ($21,716 ÷ $37,349) 59.3% ($89,620 ÷ $151,193)

(d) Free cash flow $4,862 – $3,928 – $380

= $554

$20,209 – $15,666 – $2,802

= $1,741

(e) Earnings per share

$3.21 = $2, 787

869

$3.02 = $12, 603

4,168

(f) The comparison of the two companies shows the following: Liquidity—Target’s current ratio of 1.3:1 is much better than Wal-Mart’s .90:1 and Target has significantly higher working capital than Wal-Mart. Solvency—Wal-Mart’s debt to total assets ratio is about 2% more than Target’s but its free cash flow is much larger. Profitability—Target’s earnings per share is about 6% higher than Wal-Mart’s.



PROBLEM 2-8A

(a) Financial reporting is the compilation and presentation of financial infor-

mation for a company. It provides information in the form of financial statements and additional disclosures that is useful for decision making. The accounting rules and practices that have substantial authoritative support and are recognized as a general guide for financial reporting purposes are referred to as generally accepted accounting principles (GAAP). The biotechnology company that employs Cindy will follow GAAP to report its assets, liabilities, stockholders’ equity, revenues, and expenses as it prepares financial statements.

(b) Cindy is correct in her understanding that the low success rate for new

biotech products will be a cause of concern for investors. Her suggestion that detailed scientific findings be reported to prospective investors might offset some of their concerns but it probably won’t conform to the qualitative characteristics of accounting information. These characteristics consist of relevance, reliability, comparability, and consistency. They apply to accounting information rather than the scientific findings that Cindy wants to include.



PROBLEM 2-1B

KELLOGG COMPANY Balance Sheet


Assets Current assets Cash and cash equivalents ................................ $ 410.6 Accounts receivable, net .................................... 944.8 Inventories ........................................................... 823.9 Other current assets ........................................... 247.7 Total current assets .................................... $ 2,427.0 Property, net ............................................................... 2,815.6 Other assets ................................................................ 5,471.4 Total assets ......................................................... $10,714.0

Liabilities and Stockholders’ Equity Current liabilities Notes payable ..................................................... $ 1,268.0 Accounts payable ............................................... 910.4 Current maturities of long-term debt ................. 723.3 Other current liabilities ....................................... 1,118.5 Total current liabilities ................................ $ 4,020.2 Long-term liabilities Long-term debt ................................................... 3,053.0 Other long-term liabilities ................................... 1,571.8 Total long-term liabilities ............................ 4,624.8 Total liabilities ..................................................... 8,645.0 Stockholders’ equity Common stock .................................................... 396.9 Retained earnings ............................................... 1,672.1 Total stockholders’ equity .......................... 2,069.0 Total liabilities and stockholders’ equity .......... $10,714.0



PROBLEM 2-2B

PINSON, INC. Income Statement


Revenues Service revenue ..................................................... $53,000 Expenses Salaries expense ................................................... $36,000 Depreciation expense ........................................... 4,300 Repair expense ...................................................... 2,900 Utilities expense .................................................... 2,100 Insurance expense ................................................ 1,200 Total expenses ............................................... 46,500 Net income .................................................................... $ 6,500

PINSON, INC. Retained Earnings Statement


Retained earnings, January 1 ...................................... $14,000 Plus: Net income ......................................................... 6,500 20,500 Less: Dividends ........................................................... 3,600 Retained earnings, December 31 ................................. $16,900



PROBLEM 2-2B (Continued)

PINSON, INC. Balance Sheet

December 31, 2010

Assets Current assets Cash ..................................................................... $ 5,300 Accounts receivable ........................................... 5,500 Prepaid insurance ............................................... 1,800 Total current assets .................................... $12,600 Property, plant, and equipment Equipment ........................................................... 31,000 Less: Accumulated depreciation ..................... (8,600) 22,400 Total assets ......................................................... $35,000

Liabilities and Stockholders’ Equity Current liabilities Accounts payable ............................................... $10,200 Salaries payable .................................................. 2,000 Total current liabilities ................................ $12,200 Stockholders’ equity Common stock .................................................... 5,900 Retained earnings ............................................... 16,900 Total stockholders’ equity .......................... 22,800 Total liabilities and stockholders’ equity .......... $35,000



PROBLEM 2-3B

(a) MILNER CORPORATION Income Statement For the Year Ended April 30, 2010

Revenues Sales revenue ................................................ $21,450 Expenses Salaries expense ........................................... $6,840 Depreciation expense ................................... 2,200 Income tax expense ...................................... 1,100 Rent expense ................................................. 760 Interest expense ............................................ 350 Total expenses ....................................... 11,250 Net income .................................................... $10,200

MILNER CORPORATION Retained Earnings Statement

For the Year Ended April 30, 2010

Retained earnings, May 1, 2009 ........................... $13,960 Plus: Net income ................................................. 10,200 24,160 Less: Dividends ................................................... 2,800 Retained earnings, April 30, 2010 ........................ $21,360



PROBLEM 2-3B (Continued) (b) MILNER CORPORATION

Balance Sheet April 30, 2010

Assets Current assets Cash ............................................................... $21,955 Accounts receivable ..................................... 9,150 Prepaid rent ................................................... 380 Total current assets ............................ $31,485 Equipment ............................................................. 25,050 Less: Accumulated depreciation ........................ 6,600 18,450 Total assets ................................................... $49,935

Liabilities and Stockholders’ Equity Current liabilities Accounts payable .......................................... $ 2,400 Income taxes payable ................................... 300 Interest payable ............................................. 175 Total current liabilities ........................ $ 2,875 Long-term notes payable ..................................... 5,700 Total liabilities ..................................... $ 8,575 Stockholders’ equity Common stock .............................................. 20,000 Retained earnings ......................................... 21,360 Total stockholders’ equity .................. 41,360 Total liabilities and stockholders’ equity ................................................. $49,935 (c) Milner Corporation reports its revenues and expenses on the income

statement with net income being the result. Net income from the income statement is reported on the retained earnings statement as an item added to beginning retained earnings as part of the determination of retained earnings at year end. The year end retained earnings is then reported as part of stockholders’ equity on the balance sheet.



PROBLEM 2-4B

(a) James appears to be more profitable. James’s net income and earnings per

share are higher than Smyth’s.

James’s net income is $148,000 ($898,000–$620,000–$55,000 – $10,000 – $65,000).

Its earnings per share is $.37 ($148,000 ÷ 400,000 shares).

Smyth’s net income is $40,000 ($450,000 – $260,000 – $134,000 – $6,000 – $10,000).

Its earnings per share is $.20 ($40,000 ÷ 200,000 shares).

(b) James’s 2010 working capital of $400,000 ($700,000 – $300,000) is over 3 times as high as Smyth’s working capital of $105,000 ($180,000 – $75,000). However, James’s 2010 current ratio of 2.3:1 ($700,000 ÷ $300,000) is slightly lower than Smyth’s current ratio of 2.4:1 ($180,000 ÷ $75,000).

(c) Smyth appears to be less solvent. Smyth’s 2010 debt to total assets ratio of 34% ($265,000 ÷ $780,000)a is slightly higher than James’s ratio of 33% ($500,000 ÷ $1,500,000)b. The lower the percentage of debt to total assets, the lower the risk that a company may be unable to pay its debts as they come due.

Smyth’s free cash flow is only $12,000 ($36,000 – $20,000 – $4,000)

compared to $115,000 ($180,000 – $50,000 – $15,000) for James. More free cash flow indicates that James will be better able to finance more capital expenditures without taking on more debt. a$265,000 ($75,000 + $190,000) is Smyth’s 2010 total liabilities. $780,000 ($180,000 + $600,000) is Smyth’s 2010 total assets.

b$500,000 ($300,000 + $200,000) is James’s 2010 total liabilities. $1,500,000 ($700,000 + $800,000) is James’s 2010 total assets.



PROBLEM 2-5B

(a) (i) Current ratio = $319,100

$149,200 = 2.1:1.

(ii) Working capital = $319,100 – $149,200 = $169,900.

(iii) Debt to total assets ratio = $279,200

$784,400 = 36%.

(iv) Free cash flow = $71,300 – $42,000 – $10,000 = $19,300.

(v) Earnings per share = $99,200

65,000 = $1.53.

(b) During 2010, Windsor’s current ratio decreased from 2.4:1 to 2.1:1 and its

working capital dropped from $178,000 to $169,900. Both measures indicate a slight decline in liquidity during 2010.

Windsor’s debt to total assets ratio increased from 31% in 2009 to 36% in

2010 indicating that the company is less solvent in 2010. Using another measure of solvency, free cash flow, we see that Windsor’s solvency has improved during 2010. Earnings per share increased from $1.35 to $1.53 in 2010. This 13% increase indicates better profitability in 2010.



PROBLEM 2-6B

2009 2010

(a)

Earnings per share.

$163,000

320,000 shares = $.51

$140,000

370,000 shares = $.38

(b)

Working capital.

($24,000 + $55,000 + $73,000) – $75,000 = $77,000

($40,000 + $90,000 + $74,000) – $93,000 = $111,000

(c)

Current ratio.

$152,000

$75,000 = 2.03:1

$204,000

$93,000 = 2.19:1

(d)

Debt to total assets.

$145,000

$649,000 = 22.3%

$183,000

$807,000 = 22.7%

(e) Free cash flow. Free cash flow. $178,000 – $45,000 – $43,000

= $90,000 $165,000 – $85,000 – $50,000

= $30,000

(f) The underlying profitability of the corporation as measured by earnings per share has declined. The liquidity of the corporation improved as shown by the increase in working capital and the current ratio. Also, the corporation appears to be increasing its debt burden as its debt to total assets increased slightly indicating a decrease in solvency. Comparing free cash flow, we find a drop in this measure of solvency also.



PROBLEM 2-7B

Ratio Blockbuster Inc Movie Gallery, Inc.

(All Dollars Are in Millions)

(a) Working capital $171 ($1,566 – $1,395) ($29) ($239 – $268)

(b) Current ratio 1.12:1 ($1,566 ÷ $1,395) .89:1 ($239 ÷ $268)

(c) Debt to total assets ratio 71.6% ($2,246 ÷ $3,137) 120.6% ($1,390 ÷ $1,153)

(d) Free cash flow $329 – $79 – $11 = $239 ($10) – $20 – $0 = ($30)

(e) Earnings (Loss) per share $0.29 =

$55 – 0

189.0

($0.82) =

($26) – 0

31.8

(f) The comparison of the two companies shows the following: Liquidity—Blockbuster’s current ratio is 1.12:1 compared to Movie Gallery’s .89:1. Its working capital is $171 compared to Movie Gallery’s negative $29. Blockbuster is much more liquid than Movie Gallery using either indicator. Solvency—Blockbuster is more solvent than Movie Gallery because its ratio of debt to total assets is significantly lower and its free cash flow is much larger. Profitability—The profit picture is bleak for Movie Gallery. It reported an $0.82 loss per share compared to Blockbuster’s $0.29 earnings per share.



PROBLEM 2-8B

(a) The primary objective of financial reporting is to provide information useful

for decision making. Since Net Nanny’s shares appear to be actively traded, investors must be capable of using the information made available by Net Nanny to make decisions about the company.

(b) The investors must feel as if the company will show earnings in the future.

They must recognize that information relevant to their investment choice is indicated by more than Net Nanny’s net income.

(c) The change from Canadian dollars to U.S. dollars for reporting purposes

should make Net Nanny more comparable with companies traded on U.S. stock exchanges.



BYP 2-1 FINANCIAL REPORTING PROBLEM

(a) Total current assets were $199,726,000 at December 31, 2007, and

$190,917,000 at December 31, 2006.

(b) Current assets are properly listed in the order of liquidity. As you will learn in a later chapter, inventories are considered to be less liquid than receivables. Thus, they are listed below receivables and before prepaid expenses.

(c) The asset classifications are similar to the text: (a) current assets, (b) property, plant, and equipment, and (c) other assets.

(d) Total current liabilities were $57,972,000 at December 31, 2007, and $62,211,000 at December 31, 2006.



BYP 2-2 COMPARATIVE ANALYSIS PROBLEM

(a) ($ in thousands) Hershey Foods Tootsie Roll

1. Working capital $1,426,574 – $1,618,770 = ($192,196) $199,726 – $57,972 = $141,754

2. Current ratio $1,426,574 ÷ $1,618,770 = .88:1 $199,726 ÷ $57,972 = 3.4:1

3. Debt to total assets

ratio

$3,623,593

$4,247,113 = 85.3%

$174,495

$812,725

* = 21.5%

4. Free cash flow

$778,836 – $189,698 – $252,263

= $336,875

$90,064 – $14,767 – $17,542

= $57,755

5. Earnings per share $214,154–0

$228,652 = $0.94

$51,625 –0

54,980 = $0.94

*$57,972 + $116,523

(b) Liquidity Tootsie Roll is much more liquid since it has over $330 million more

working capital than Hershey. In addition, Tootsie Roll’s current ratio is almost four times as large as Hershey’s.

Solvency

Based on the debt to total assets ratio, Tootsie Roll is more solvent. Tootsie Roll’s debt to total assets ratio is significantly lower than Hershey’s and, therefore, Tootsie Roll would be considered better able to pay its debts as they come due. Comparing free cash flow, Hershey generates much more excess cash, but both companies generate significant amounts of cash to pay debt, distribute dividends, or expand operations. Profitability Earnings per share of the two companies are the same. It should be noted that additional measures of profitability are needed to provide a better picture for comparison.



BYP 2-3 RESEARCH CASE

(a) In 2007, 56% of survey respondents said that they had observed violations of

company ethics standards, policy, or the law. This compares with 52% in 2005 and only 46% in 2003.

(b) The three most frequent types of observed misconduct were conflicts

of interest (23%), abusive or intimidating behavior (21%) and lying to employees (20%).

(c) More than 42% of employees who witnessed misconduct didn’t report it

through company channels. The two most common reasons given for not reporting were a belief that reporting wouldn’t lead to corrective action (54%) and fear of retaliation (36%).

(d) The key elements of an effective ethics and compliance program are:

Employees are willing to seek advice about ethics questions. Employees feel prepared to handle situations that could lead to

misconduct. Employees are rewarded for ethical behavior. Employees do not believe their company rewards success obtained

through questionable means. Employees feel positive about their company.



BYP 2-4 INTERPRETING FINANCIAL STATEMENTS

(a) The percentage decrease in Gap’s total assets during this period is

calculated as:

$8,544 – $10,283

$10,283 = 17%

The average decrease per year can be approximated as:

17%

4 years = 4% per year

(b) Gap’s working capital decreased during this period while its current ratio increased slightly, indicating a decline in liquidity. The current ratio is a better measure of liquidity because it provides a relative measure; that is, current assets compared to current liabilities. Working capital only tells us the net amount of current assets less current liabilities. It is hard to say whether a given amount of working capital is adequate or inadequate without knowing the size of the company.

(c) The decrease in the debt to total assets ratio suggests that Gap’s sol-vency improved during the period, as the percentage of debt used to finance its assets decreased. Debt to total assets peaked at .66:1 in 2002 and then declined to .38:1 by 2005.

(d) The earnings per share suggests that Gap’s profitability improved signifi-cantly from 2002 to 2004, increasing from $.55 to $1.29. However, based on the years shown, it appears that earnings varied a great deal during this period. An investor would want to evaluate the causes of the 25% decline in 2006 to predict the likelihood of future decreases in earnings.



FINANCIAL ANALYSIS ON THE WEB

BYP 2-5 Answers will vary depending on company chosen and date. BYP 2-6 Answers will vary depending on company chosen and date.



BYP 2-7 DECISION MAKING ACROSS THE ORGANIZATION

The current ratio increase is a favorable indication as to liquidity, but alone tells little about the prospects of the client. From this ratio change alone, it is impossible to know the amount and direction of the changes in individual accounts, total current assets, and total current liabilities. Also unknown are the reasons for the changes. The working capital increase is also a favorable indication as to liquidity, but again the amount and direction of the changes in individual current assets and current liabilities cannot be determined from this measure. The increase in free cash flow is a favorable indicator for solvency. An increase in free cash flow means the company can replace assets, pay dividends, and have “free cash” available to pay down debt or expand operations. The decrease in the debt to total assets ratio is a favorable indicator for solvency and going-concern prospects. The lower the percentage of debt to total assets, the lower the risk that a company may be unable to pay its debts as they come due. A decline in the debt to total assets ratio is also a positive sign regarding going-concern potential. The increase in net income is a favorable indicator for both solvency and profitability prospects although much depends on the quality of receivables generated from sales and how quickly they can be converted into cash. A significant factor here may be that despite a decline in sales the client’s man-agement has been able to reduce costs to produce this increase. Indirectly, the improved income picture may have a favorable impact on solvency and going-concern potential by enabling the client to borrow currently to meet cash requirements. The earnings per share increase is a favorable indicator for profitability. A 109% (from $1.15 to $2.40) increase indicates a significant increase in net income and provides a favorable sign regarding going-concern potential.



BYP 2-8 COMMUNICATION ACTIVITY

To: T. J. Rains From: Accounting Major Subject: Financial Statement Analysis

(a) Ratios can be classified into three types, which measure three different aspects of a company’s financial health:

1. Liquidity ratios—These measure a company’s ability to pay its

current obligations. 2. Solvency ratios—These measure a company’s ability to pay its long-

term obligations and survive over the long-term. 3. Profitability ratios—These measure the ability of the company to

generate a profit.

(b) 1. Examples of liquidity measures are: Working capital = Current assets – Current liabilities

Current ratio = Current assets

Current liabilities

2. Examples of solvency measures are:

Debt to total assets ratio = Total liabilities

Total assets

Free cash flow = Cash provided by operating activities – Capital expenditures – Cash dividends



BYP 2-8 (Continued) 3. Example of profitability measure:

Earnings per share = Net incomePreferred stock dividends


(c) There are three bases for comparing a company’s results: The bases of comparison are: 1. Intracompany—This basis compares an item or financial relationship

within a company in the current year with the same item or relationship in one or more prior years.

2. Industry averages—This basis compares an item or financial relation-

ship of a company with industry averages (or norms). 3. Intercompany—This basis compares an item or financial relationship

of one company with the same item or relationship in one or more competing companies.



BYP 2-9 ETHICS CASE

(a) The stakeholders in this case are: Boeing’s management; CEO, public

relations manager, Boeing’s stockholders, McDonnell Douglas stock-holders, other users of the financial statements; especially potential investors of the new combined company.

(b) The ethical issues center around full disclosure of financial information.

Management attempted to “time” the release of bad news in order to complete a merger that would have been revoked if cost overruns had been disclosed as soon as management became aware of them.

(c) The time period assumption requires that financial results be reported on

specific, pre-determined dates.

The full disclosure principle requires that all circumstances and events that make a difference to financial statement users must be disclosed.

(d) It is not ethical to “time” the release of bad news. GAAP requires that all

significant financial information be released to allow users to make informed decisions.

(e) Answers will vary. One possibility: Release the information regarding

cost overruns as it became available. Describe the causes of such overruns and explain how Boeing would address them (probably by improving production methods to eliminate the inefficiencies alluded to in the text).

(f) Investors and analysts should be aware that Boeing’s management will

probably “manage” information in the future in ways that will interfere with full disclosure.



BYP 2-10 ALL ABOUT YOU ACTIVITY

Answers will vary.

chapter 2 · the major differences between current liabilities and long-term liabilities are: ......

Documents